Avoid Misuse of Your $1,400 Stimulus Funds

 Posted on March 22, 2021 in Bankruptcy

Paying your stimulus money to various combinations of creditors, in the hopes of avoiding bankruptcy or before a planned one, is dangerous.

Before You Make Decisions That Hurt You

Last week we introduced the radical idea that the best use of your upcoming or already received $1,400 stimulus payment might be to pay for a bankruptcy case. We focused then on how to figure out when you should throw in the towel and decide to file bankruptcy. One clue is if you find yourself making questionable decisions. That can mean that you are starting to feel desperate. Then the bad decisions can turn your situation even worse.

The problem is that you often do not have enough information to know whether a financial decision is a smart one. They often involve having legal knowledge that you would have no reason to know. It is often impossible to know what is sensible and what is not without understanding the legal consequences. Today we give some examples where sensible-seeming choices end up being a mistake.

Paying the Tax Man

Let us say you owe the IRS $10,000 in income taxes from a tax year of a few years ago. You are expecting to get $5,600 in the new stimulus payments ($1,400 times 4 for a family of 2 adults and 2 kids).

You might figure the IRS will just take your $5,600 stimulus money in payment for the taxes you owe. Not true: The stimulus payment “cannot be offset to pay various past-due federal debts or back taxes.” IRS News Release, March 12, 2021.

You also figure the IRS will put a tax lien on your home or other possessions at any time. You are afraid of your paycheck getting garnished, and your employer finding out about your tax debt. These two likely ARE realistic fears.

So you decide to pay the $5,600 to the IRS and then work out a monthly payment plan for the balance.

Maybe Do Not Give the IRS Your Stimulus Money

Under certain circumstances, paying your stimulus money to the IRS would essentially be a waste of $5,600. And it could be a waste of whatever else you would pay on this $10,000 debt. That is because you may be able to completely discharge—legally write off—that debt. The tax just needs to be old enough and meet a couple of other conditions. You could do that with either of those or Chapter 13 “adjustment of debts.”

The $10,000 income tax debt might qualify for complete discharge under a Chapter 7 “straight bankruptcy.” 

Even if it would not qualify (such as if it were too recent), Chapter 13 “adjustment of debts” could really help. It would give you a lot of flexibility in paying off the tax debt. You may well have more urgent uses of the stimulus money—paying child support or catching up on a mortgage. With Chapter 13, you would pay the IRS more on your own schedule, and likely avoid additional interest and tax penalties. Plus, you would be protected from the IRS’ aggressive collection activities during that time, as well as from other creditors.

So, in this example, if you would financially invest in bankruptcy, that could save you $10,000 (plus future interest and penalties). Or at least it would enable you to better prioritize your financial obligations. Either way, it would buy you peace of mind in the meantime.

Other Situations

There are literally dozens of other situations like this IRS one where a sensible-seeming decision can backfire on you. Here are a few more:

Waiting for the Stimulus While a Creditor Gets a Judgment Lien

For many people, the stimulus payments have already arrived or are coming very soon. But for some people, it will take a while. If you own a home, be careful about letting a creditor get a judgment against you in the meantime. The judgment can turn very quickly into a lien against your home. So instead of having a debt that you can completely wipe in bankruptcy, it is one you have to pay in full. Meanwhile, you risk losing your home. Instead, filing bankruptcy would prevent the judgment and the judgment lien. Obtain sound legal advice before these kinds of irreversible events occur.

Dividing up the Stimulus Payment Among Your Creditors

You get the stimulus payment and decide to do “the honorable thing.” You distribute the money among all of your creditors. Several months later you are back to not being able to pay your debts. You end up filing bankruptcy a year from now after a creditor has garnished your wages for several months. While your pay was being garnished, you did not have the money to pay the bankruptcy filing fee and lawyer fees. The end result: You effectively lost the benefit of the stimulus money. Then you paid out more money than you would have otherwise. You dealt with further aggravation and delayed starting to rebuild your credit another year.

Paying the Stimulus Payment to the Most Aggressive Creditor

You pay the stimulus check to your ex-spouse for back child support. That makes a lot of sense in most situations. There is no more legally powerful and scary creditor than the ex-spouse or the support enforcement agency. But let us say you lose your car to repossession because you did not pay the money there instead. If you filed a Chapter 13 case instead of paying the ex-spouse, you could stop both the repossession and support enforcement. This would happen for long enough for you and your bankruptcy lawyer to put together a payment plan that would eventually satisfy both. And there is a good chance you could reduce both your vehicle payment and the total you would pay on that debt.

Paying the Stimulus Payment to a Favored Creditor

You use the stimulus money to pay off a friendly creditor. You do that hoping to avoid filing bankruptcy. Or you might even consider doing this before filing bankruptcy in the hopes of excluding this creditor from it. Either way, paying off a friendly creditor can backfire. If you decide to file bankruptcy or are forced into it, the friendly creditor may have to give the money “back” to the bankruptcy trustee. It depends on the timing. Then you may still feel indebted to that creditor and could end up paying that debt twice!

The Best Advice? Get Good (Legal) Advice

If you are experiencing financial hardship, you simply cannot make good financial decisions without knowing their legal consequences. The best way to know all of the potential legal consequences is to talk with a bankruptcy lawyer. He or she has the legal knowledge and the practical experience to advise you about the legal and practical consequences of your decisions.